USD/CAD clings to gains near 1.2700 amid modest USD strength/retreating oil prices

• USD/CAD regained positive traction on Tuesday and was supported by a combination of factors.
• Retreating oil prices undermined the loonie and extended support amid modest USD strength.
• The mixed fundamental backdrop might cap any further gains ahead of the US CPI on Thursday.

The USD/CAD pair maintained its bid tone heading into the North American session and was last seen trading near the daily high, just above the 1.2700 mark.

A combination of factors assisted the USD/CAD pair to catch fresh bids on Tuesday and recover a part of the overnight losses back closer to the 1.2450 support zone. Crude oil prices pulled away from the seven-year high touched last Friday and undermined the commodity-linked loonie. Apart from this, modest US dollar strength acted as a tailwind for the major.

Expectations that the revival of the 2015 international nuclear agreement could return more than 1 million barrels per day of Iranian oil – equating to more than 1% of global supply –  in the markets. This, in turn, prompted traders to lighten their bullish bets ahead of the indirect talks between the United States and Iran, due to resume in Vienna on Tuesday.

On the other hand, the greenback drew some support from a fresh leg up in the US Treasury bond yields, bolstered by speculations for a faster policy tightening by the Fed. In fact, the markets have been pricing in the possibility of a full 50 bps rate hike at the March FOMC meeting amid worries about stubbornly high inflationary pressures.

This, in turn, pushed the yield on the benchmark 10-year US government bond well within the striking distance of the 2.0% threshold. Adding to this, the 2-year and 5-year notes – which are highly sensitive to rate hike expectations – held steady near the highest level since February 2020 and July 2019, respectively, and underpinned the greenback.

Hence, the market focus will remain glued to the release of the US consumer inflation figures on Thursday. The US CPI report will determine the Fed's near-term policy outlook and help determine the next leg of a directional move for the USD/CAD pair. In the meantime, traders might prefer to wait on the sidelines and refrain from placing aggressive bets.

Moreover, hopes that global supply would remain tight amid the post-pandemic recovery in fuel demand, along with the conflict between Russia and the West over Ukraine should limit losses for oil prices. This, in turn, should lend some support to the Canadian dollar and further contribute to capping the USD/CAD pair amid absent market-moving economic data.

Technical levels to watch